How Does Payment Processing Work? Everything You Need to Know

Payment processing is an integral part of any business offering online transactions. It refers to the sequence of steps and systems that enable purchases — from verifying payment details to authorizing and settling funds between the customer and the merchant. Whether you are selling goods or services, payment processors make it possible for customers to complete purchases with just a click. There are many types of processors, but they all have one thing in common — they charge fees for their services. These fees can be flat or percentage-based, depending on your agreement. Still, every online transaction involves multiple steps before it’s finalized. So, how does an online transaction actually work?

This is a question that many people ask, but few know how to answer. That’s where this blog post comes in handy! We will talk about the online payment basics and how online transaction works. So, keep on reading.

Who Are the Participants in the Payment Processing System?

There are six key participants in an online payment transaction: customer, business owner, payment aggregator, acquiring bank, card networks and issuing bank. They all play different roles with one goal – to complete a successful purchase.

The first participant is your customer who wants to make a purchase from you. Next up we have you (the business owner) and your bank that work together on processing the payment request sent by your customer’s credit card issuer or other financial institution such as PayPal. Your role is to ensure that all steps of the process go smoothly while at the same time protecting yourself and your money against fraudsters trying to set up fake transactions using stolen information like credit cards numbers, etc. Finally, there is an aggregator, which takes care of sending requests to acquirers and ensuring that transactions are completed.

This is how an online transaction works with the help of the players involved. Let’s take an in-depth look at how these entities work to make the online transaction process smoother.

1. Customer: A customer is someone who wants to make a purchase from you. So, he/she is the primary entity of an online transaction process.
2. Business owner: This is you! You are the second participant in an online transaction process. You have to work together with your bank on processing a payment request sent by your customer’s credit card issuer or other financial institution such as PayPal.
3. Payment Aggregator: A payment aggregator allows merchants to accept online payments without having to set up a dedicated merchant account. While it may include a payment gateway as part of its offering, it also handles routing transactions to acquiring banks and managing settlements under a shared infrastructure.
4. Acquiring Bank: Acquiring bank is the next participant in this process, which acts as a liaison between payment aggregators and issuer banks. It manages a merchant’s accounts receivable, handles disputed transactions, and most importantly, ensures that merchants get paid for the products/services they sell.
5. Card Network: Card networks like Visa or Mastercard connect acquiring and issuing banks. They define transaction rules, facilitate authorization and settlement processes, and ensure interoperability between financial institutions. These networks also offer fraud prevention tools — for example, Mastercard maintains the MATCH list to detect high-risk merchants, while Visa provides Verified by Visa (VbV) as part of its identity verification program. By enforcing standardized protocols, card networks help ensure that online transactions are processed securely and efficiently.
6. Issuing Bank: Issuer banks are the ones who actually issue credit cards to customers. They also maintain a record of each transaction with your business, which means they will be able to provide you with accurate data on card spending and outstanding payments. There is an issuer bank for every unique credit or debit card number out there. So, it’s very important that you keep track of this information when accepting online transactions from customers using their respective cards. This way, if ever something goes wrong in processing payment requests sent by acquirers, such as incorrect expiration dates or CVV codes (the three digits found on the back of all India-issued Visa/Mastercard cards), then issuers can quickly flag them before fraudsters get a chance to steal your customers’ money.

What Is the Payment Process and How Does It Work?

Now that you know the entities involved in payment processing, let’s take a look at the steps involved in how a payment is processed.

1. Transaction Verification: The first step of an online transaction process is verification, where acquirers confirm that your business and issuer bank are authorised to accept payments from customers using their respective cards.
2. Payment Request Authorisation: Once this validation takes place, you can receive authorisation for the requested amount from acquiring banks by sending them all necessary information such as billing address, card number or expiration date, etc., so they can forward it on to issuers for approval. In some cases, when frauds have been reported against a particular credit card number – which will be flagged by issuing banks – acquisition requests sent by acquiring banks may also get rejected due to lack of proper authentication required at the time of processing online transactions.
3. Transaction Settlement: After the transaction is authorized, funds are settled by the acquiring bank — usually within one business day (T+1), though some providers offer instant settlement depending on your agreement. In contrast, account-to-account (A2A) payments can settle instantly without card networks or intermediaries, offering a more streamlined alternative in many cases. Issuers will also get notified of this settlement process, which means customers’ accounts are debited and merchants’ accounts credited accordingly in real-time/after some delay. This phase involves the actual transfer of money from the customer’s card to the merchant bank account for the successful completion of an online payment transaction.

In case any disputes happen regarding a particular purchase made using credit cards (such as when a product received by a consumer doesn’t match what was advertised), then banks may hold funds until all parties involved negotiate amicably about their grievances or go through legal proceedings to settle such disputes. This process is known as a chargeback, and it can potentially harm your online business credit worthiness if there are too many of these happening repeatedly with different customers.

Simply put:

1. The customer pays the merchant via credit card.
2. The merchant forwards the request to the payment aggregator.
3. The payment aggregator sends an authorisation request to the card issuer.
4. If the transaction is approved by the issuing bank, the customer’s card is debited and the money is transferred to the acquiring bank.

What Are Chargebacks in the Payment Process?

A chargeback occurs when a cardholder disputes a transaction that appears on their statement — for example, due to a defective product, an unrecognized charge, or non-delivery of goods. When this happens, the issuing bank initiates an investigation by contacting the merchant and requesting details about how the transaction was processed and authorized.

If the chargeback is resolved in favor of the cardholder, the transaction amount is refunded from the merchant’s account. Additionally, most payment providers impose a chargeback fee, which can accumulate quickly if disputes occur frequently. High chargeback ratios may also impact your credibility as a merchant and lead to higher processing costs or even account termination.

Understanding the Payment Processing Procedure: Conclusion

Understanding how payment processing works — from the roles of key participants to the steps of authorization and settlement — is essential for any online business. By choosing reliable partners and monitoring each stage, you can improve conversion rates and reduce the risk of fraud.